Frontier Sovereigns’ Rookie Issue Mistakes
An IMF working paper looking at $15 billion in debut external frontier country bonds mainly from Africa the past decade advised “risk-mitigating policies” to meet currency, refinancing, and management challenges as it fleshed out generic warnings from Director Lagarde in recent Sub-Sahara visits. The two dozen issues covered were at least $200 million from the central government also in Asia, Europe, Latin America and the Middle East and prompted both by demand and supply conditions. During the 2008-09 crisis only Georgia and Senegal came to market but since 2010 yield search with low global interest rates opened the floodgates to 15 peers. Most have been in dollars with fixed-coupon bullet maturities from 5-10 years and junk ratings. Their chief use was infrastructure projects that local markets could not fund and graduation from lower to middle-income status likewise reduce previously available concessional lines to motivate international private access. The proceeds as well went for budget coverage, debt restructuring, and corporate benchmarking, as official relief under bilateral and multilateral programs cut ratios below 60 percent of GDP. Credit ratings upgrades to the BB-minus range were the norm before placement especially in Asia and Latin America. Growth and inflation indicators improved, with half the sample projecting annual 5 percent medium-term expansion, as economic and debt burden strides paralleled the early emerging market efforts post-Brady Plan in the 1990s, according to the Fund. Unlike then new issuers have solid reserve positions to withstand capital “sudden stops,” but budget and current account imbalances have often worsened. They have paid a “novelty premium” of 50 basis points, and in some cases like Tanzania’s 2013 floating rate note structures were poorly chosen to increase costs. Building on previous research secondary market spreads are driven by economic indicators, financial and institutional development, and risk appetite modeled in statistical regressions, and they are typically wider than in the core EMBI. During last year’s Fed taper fright they sold off less than more widely-held liquid instruments, bur the study suggests possible convergence over a longer correction period. Their dedicated and real money investor base is “more stable,” with African paper bought equally by US and European houses. Sustainability is at issue where the amounts represent 15-20 percent portions of output as with Mongolia and Seychelles, as the latter subsequently conducted an exchange supported by an IMF arrangement after missing interest and principal payments in 2008.
Currency mismatch is another problem as Gabon and Tanzania already have high FX debt. Maturity profiles with “bullets” amortizing entirely at the end are potential complications, particularly as rising global rates deter rollover. Debt management capacity and governance and investor relations and independent advice are often lacking, the survey finds. Credit ratings should be obtained in advance to reduce costs, and outside legal and financial help unassociated with the underwriters must be enlisted to ensure longer-term benefits with encore performances as in Ghana and Bolivia, it adds.
